CFO’s guide: Transition to IFRS 16

IFRS 16 allows a number of choices when choosing the transition method in applying the Standard. Choosing the most appropriate transition option will require careful analysis across a number of factors as highlighted in Section 2 of this article.

The transition choices available under IFRS 16 are:

^{* Option 2B is a simplification of Option 2A, and can be elected on a lease-by-lease basis when adopting the modified retrospective approach.}

Whatever the transition approach choice, there are four key practical expedients and exemptions available for all lessees:

1. Utilise the Grandfathering provision in IFRS 16 during year of transition (to apply for all contracts if used);
2. Exemption from IFRS 16 requirements for lease contracts with a lease term (as defined in IFRS 16) of 12 months or less (to apply for entire class of asset if used);
3. Exemption from IFRS 16 requirements for lease contracts where the underlying asset is of low value (lease-by-lease basis choice); and
4. Make an accounting policy choice to not separate non-lease components from lease components (to apply for entire class of asset if used).

Additionally, when applying Option 2A & 2B, lessees can also make use of one or more of the following practical expedients (on a lease-by-lease basis) for previously classified operating leases:

1. Applying a single IBR to a portfolio of leases with reasonably similar characteristics;
2. Relying on an onerous lease assessment performed in the last ‘IAS 17 reporting period’, as an alternative to performing an impairment review at the date of initial application of IFRS 16;
3. Electing to treat certain lease contracts as short-term leases, when their lease term (as defined in IFRS 16) ends within 12 months of the initial IFRS 16 application date;
4. Excluding initial direct costs from the measurement of the RoU Asset at the date of initial application; and
5. Using hindsight, such as in determining the lease term if the contract contains options to extend or terminate the lease.

The available IFRS 16 transition choices essentially provide a trade-off between implementation cost and the extent of disclosure and impact on a group’s financial statements. A careful analysis is required on the choice of transition approach, as this will not only affect financial statements at the adoption date but also for future years. As part of this, groups should consider:

• In many instances, the most straightforward modified retrospective Option 2B may be the most practical and cost efficient approach for groups with limited use of leases. Where a group, however, is more lease intensive it may become more relevant to consider the full retrospective approach - which provides greater comparability of presented financial information and potentially the least adverse impact on profitability post implementation;
• The availability of data may impact the range of options available - for example where groups are not able to obtain key historical data for lease extensions, renewals, pricing changes and discount rates, such data gaps can impact the ability to apply the full retrospective approach;
• As part of assessing transition options we would recommend entities to undertake the below key steps as part of identifying their preferred option:

1. Consider the key impact areas (outlined above) and the group’s preferences in each, including qualitative factors such as stakeholder needs and sensitivity, along with past precedence the group has adopted for recent accounting changes.
2. Model the impact of the three IFRS 16 transition options on a relevant sample number of contracts to understand directional impact possibilities.
3. Evaluate current data availability for applying all three approaches, along with timescale and external resources requirements (if any) to gather missing data points.